Business Accounting – The Two Main Accounting Methods
Accounting techniques are the different ways in which a business will organize their financial records in preparation for financial reports. There are two main methods to choose from, which are called the accrual basis and the cash basis. The method chosen will depend on a number of factors, including IRS (Internal Revenue Service) tax requirements, sales volume and if the business gives credit to customers.
Although these records are needed by law, they can also be useful for business owners when it comes to business decisions based on financial situations. The method chosen by small business owners is important because although the technique can be changed at a later date it can be difficult to make the change over. With this in mind small business owners need to really think about which technique most suits their business.
Cash basis accounting records focus on how cash flows in real time, factoring in how income and expenses are calculated with that method. Once you physically get funds into your account, that is recorded as income, instead of just recording when you earned it. Expenses, on the other hand, are factored in when the money actually leaves your hands, instead of when they are ‘spent’. With the help of this accounting method, you can delay billing if you like, so you can place it in the following year and hedge your bets with the IRS, or pay things earlier to avoid later trouble.
The cash basis has its benefits. It is easier to understand and carry out than the accrual technique, cash flow is depicted accurately and you can delay taxation of income until you actually have it. Expenses and your revenue depends upon on when you receive and pay out money, although this can be a benefit it can also be a disadvantage because it can give an inaccurate image of the financial situation for a business. This is where the accrual basis comes into play, it differs from the cash basis because it recognizes expenses and income when they apply and not just when the cash has changed hands, leading to a more accurate depiction of a businesses financial situation in any given period.
With the accrual basis of accounting. you record income and payments when you actually earn them, instead of when you choose to pay them. With the accrual method, you will have a much better notion of how you are doing financially in the long term. However, it is far more complicated to figure out and record, and you might have to pay income taxes on the money you bring in before you actually get it, which can be unfortunate to go through.